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Marcin Malmon


Szczerze o nieruchomościach

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Equated Yield

The equated yield is mathematically the same as the equivalent yield and can be determined in a very similar way as I have described in relation to the eqiuvalent yield. The difference in the analysis with Excel’s “Goal seek” function will be that the residual value will be calculated using a different rate and only this will be taken into account in the aforementioned goal seek, i.e. the discount rate that is needed for the discounted residual value as well as all previous income streams to add up to the recorded transaction price. The difference, however, lies in the fact that in a real estate transaction analysis, a different type of cash flow, the so-called explicit cash flows, must be used to determine the equated yield. This fact results in the just-mentioned need for the existence of some known capitalisation rate (specifically an “exit yield”), so that an equated yield can be derived from the analysis.

For obvious reasons, the practical usefulness of such an analysis is severely limited. However, I cite it in order to highlight the somewhat twin nature of the equivalent yield and the equated yield and to raise awareness of the importance of distinguishing between them and using them only in the right kinds of cash flow.

In contrast to implicit cash flow, explicit cash flow already contain subjective assumptions about the projected changes in the profitability of properties resulting from expected changes in market conditions in the future. Thus, it is possible to imagine a forecast based on the assumption of a drop in market rents in e.g. 2 years’ time, taking into account the currently observed large amount of e.g. office space under construction, which will be delivered to the market just in 2 years’ time, causing oversupply and an increase in the vacancy rate, which in turn will exert downward pressure on market rents. In the Polish reality, a more common example may also be the indexation of rents over the entire forecast period, applied by some international companies, and not only over the duration of lease agreements, as was the case with implicit cash flow.

A projection in the form of explicit cash flow therefore contains many more subjective elements assumed by the investor or valuer. In the case of rent indexation, it can be important whether we index the rents only in the contractual period or whether we also index the market rent in subsequent years. A cash flow structured in this way is usually much more optimistic and therefore the rate used to discount (i.e. equated yield) the resulting income streams must be correspondingly higher to give the same price (or value) as would be obtained by discounting the flows from implicit cash flow. Depending on the magnitude of the subjective assumptions introduced, the spread between the equated yield and the equivalent yield can be significant. This makes it clear how crucial it is to be aware of which rate you are obtaining information about from the market, so that you can then use it appropriately, for example in the valuation of another property.

It should also be noted that explicit cash flows contain subjective projections of the change in the level of rental income over a certain period assumed by the analyser, e.g. 10 years. Afterwards, however, the residual value is calculated, using the capitalisation rate (specifically one type of capitalisation rate i.e. exit yield). Since, in the example 10-year projection period, the rental growth element was introduced directly into the income stream flows, the discount rate (equated yield) should be higher than the exit rate used to determine the residual value. This is because in the latter case, simple capitalisation is carried out, which does not allow for the possibility of introducing forecasts of income growth directly, but only by means of the level of the rate itself.

It is also worth noting that having information on the flow of income streams in the form of implicit cash flow will result in an ‘All Risks Equivalent Yield’ as a result of the analysis. In contrast, it is not possible to determine the All Risks Yield as equated.

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